Critical issues shaping global economic outlook

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The good news for the industrialized economies, including the U.S., is that inflation is not a problem.

The good news for U.S. farmers is that the dollar will continue to depreciate against most currencies over the next few years.

It is important to point out that the issues are different commodity by commodity. There are specific factors with each commodity that relate to inventories, to production, to supply response and, very importantly, to policies. This is particularly true in the case of agriculture.

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A bigger headache

In places like China, India, and Brazil inflation is a bigger headache. As a result, central banks in the U.S., Europe and Japan are in no hurry to raise historically low interest rates. Whereas in many emerging markets we are already starting to see interest rates rising — in some cases quite substantially.

The outlook for the U.S. dollar is being determined by the global trends I have already mentioned. The U.S. is a relatively slow-growing economy compared to the emerging markets. Interest rates are on hold; whereas they are rising in the emerging world. Predictably this will exert downward pressure on the dollar.

I mentioned earlier that the only exception to this trend is the euro, because of the sovereign debt problems in Europe. The dollar will fall against most emerging market currencies, including the Chinese currency, which has risen 25 percent against the dollar in the last five years, about 5 percent a year. We expect it to continue that path for some time.

People extrapolate from the current weakness of the dollar and assert that the dollar is no longer going to be the reserve principal currency of the world. This is nonsense. There is no alternative to the dollar, at least for the next 5 to 10 years.

I often joke and say, the dollar is still the best looking horse in the glue factory. Yes, we’ve got our problems, but a lot of other countries have even bigger problems than we do. People talk about the Chinese currency or the IMF’s special drawing rights (SDRs) as alternatives to the dollar, but there are major problems with each of these. At least for the foreseeable future, the dollar will remain the premier reserve currency in the world.

I will spend the last few minutes on risks. Obviously there are a lot of risks facing the global economy. The good news is that we’re in a decent growth situation. If an oil crisis is going to hit, this is not a bad time for it to hit given that the growth momentum is strong. We can absorb this.

Here is a rule of thumb: every sustained $10 increase in the price of oil cuts our growth by about .2 of 1 percent. That’s not very much. If we’re growing 4 percent, that means we only grow 3.8 percent.

Still, the commodity price situation is one thing to worry about.

The turmoil in Europe in terms of sovereign debt is another thing to worry about. Something very few people are focused on is a property bubble in China. China could have a bust on its hands next year or the year after. Too much liquidity, too much credit and too rapid a rise in real estate prices are unsustainable. Estimates are about a third of Chinese apartment buildings are empty. That is not a good situation.

On the other hand, it’s important to say that not all of the surprises are necessarily on the downside. There are some significant upside risks as well — stronger growth in U.S. consumer spending, stronger growth in U.S. productivity, more business optimism, more spending. The good news is that the probability distribution around our forecast is a little more symmetrical. So the upside and downside risks are balanced.

Bottom line I think we’re doing okay, more than okay. In fact in the U.S. this quarter we’ll probably see 4 percent growth. Unless oil prices go a lot higher than they are right now the current Middle East turmoil is not going to be a problem for the United States.